Chapter 2

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Financial Accounting
A Decision-Making Approach, 2nd Edition
King, Lembke, and Smith
*
Prepared by
Dr. Denise English,
Boise State University
John Wiley & Sons, Inc.
CHAPTER
TWO
ACCOUNTING IN A
DECISION-MAKING
ENVIRONMENT
After reading Chapter 2, you should be able to:
1. Identify the four basic financial statements and explain how the financial
statements provide useful information to decision makers.
2. Identify how the relationships that exist among the financial statements
serve to present a complete picture of a company’s operations and
financial position.
3. Understand the types of decisions that users of financial statements make
based on accounting information.
4. Explain how accounting information systems help ensure useful
information for decision makers.
5. Describe the different types of accounting activities and the role each plays
in providing information for decision makers.
6. Describe the role of accounting rules or standards in ensuring useful
information for decision makers.
7. Describe how the current social and economic environment influences the
accounting profession.
The Four Basic
Financial Statements
1) Income Statement
2) Statement of Financial Position
(Balance Sheet)
3) Statement of Cash Flows
4) Statement of Changes in
Owners’ Equity (or Statement of
Changes in Retained Earnings)
The Income Statement
Purpose: to present information concerning the
profitability of an organization for a defined
period of time.
Presentation Formula:
+ Revenues (amounts generated by the sale of
goods or services)
- Expenses (costs incurred in doing business)
---------------------------------------------------------------= Net Income (Loss)
====================================
Statement of Financial Position
(also known as the Balance Sheet)
Purpose: provide information about all of the
organization’s resources and the claims
against those resources at a point in time.
Presentation formula:
Assets
= Liabilities + Owners’ Equity
(resources of
value providing
future benefit)
(claims against the assets)
(by creditors)
(by owners)
Statement of Cash Flows
Purpose: provide information about the sources and
uses of cash due to operating, investing, and
financing activities for a defined period of time.
Presentation Formula:
Net cash provided (used) by operating activities
+ Net cash provided (used) by investing activities
+ Net cash provided (used) by financing activities
--------------------------------------------------------------Net increase in Cash
====================================
Statement of Changes in
Owners’ Equity (or Retained Earnings)
Purpose: provide information about changes in the two
owners’ equity elements for a defined period of time.
Presentation formula:
Stockholders’ Equity =
Contributed Capital
+
Beginning Cont. Capital
+ Contributions by stkholders
----------------------------= Ending Contributed Capital
======================
Retained Earnings
Beginning Retained Earnings
+ Net Income ( or - Net Loss)
- Dividends to stockholders
_____________________
Ending Retained Earnings
======================
The Statement of Financial Position
The Statement of Financial Position (Balance Sheet):
Assets
(resources of
value providing
=
Liabilities
+
Owners’ Equity
(claims against the assets)
(by creditors)
(by owners)
future benefit)
This formula can also be stated as:
Assets
–
Liabilities
=
(resources of
value providing
future benefit
(creditor claims
against assets)
Owners’ Equity
(residual owners’
claims against
assets)
Relationships between the 4
basic financial statements
The Statement of Financial Position (Balance Sheet):
Assets
=
Liabilities
+
Owners’ Equity
Cash Flow
Statement:
Net Cash
generated by
Operating +
Investing +
Financing
Activities
Statement of Changes in Owners’ Equity:
Contributed Capital + Retained Earnings
Changes to
Previously Undistributed
Owners’ InvestIncome
ments
+ Net Income - Distributions
The Income Statement:
Revenues – Expenses = Net Income
Users of Accounting Information
and their Decisions
Internal Users:
Owners/managers
Allocate resources
Choose products & services
Arrange financing
Employees
Assess employment prospects
Negotiate wages and benefits
External Users:
Owners (passive)
Decide future
Select management
Creditors
Set lending practices
Regulators
Restrict profits
Set rates or prices
Establish operating
restrictions
Set collection practices
Taxing Authorities
Vendors (Suppliers)
Assess taxes
Establish compliance
Sell products & services
Extend credit
Internal Control is Important
“60% of all frauds are a result of poor internal
control” (KPMG, 1998 Fraud Survey).
Internal controls: all policies and procedures
designed to ensure that the goals of the
organization will be achieved, such as:
- safeguarding resources
- complying with applicable laws
- reporting financial information fairly.
Who wants to be a millionaire
(or at least account for millions)?
General Accountant
Cost Accountant
Tax Accountant
Independent Auditor
Internal Auditor
Academic Accountant
Consultant
CPA
Professional Accounting
Certifications
CPA
Governing body
States
CMA
Institute
of Management
Accountants
CIA
Institute
of Internal
Auditors
Approximate # of
certifications
430,000
21,000
25,000
Approximate # annually
taking exam
125,000
10,000
5,000
Education required
Varies by state
Bachelor’s
Bachelor’s
Experience required
0-3 years
2 years
2 years
Website
www.aicpa.org www.imanet.org www.theiia.org
The Role of Auditors
Financial Auditing--gathering information about an
entity to form an opinion on the fairness of its financial
statements.
Audit Reports--upon completing a financial audit
(including an assessment of internal control and relying
on the work of internal auditors as necessary), a report
is issued indicating the auditor’s responsibility and
expressing an opinion about the fairness of financial
statements. Opinion types are:
unqualified
qualified
adverse
disclaimer.
The Standard Setting Organizations




Securities and Exchange Commission (SEC)
– oversees the issuance and trading of securities of publicly held
companies and establishes reporting and disclosure
requirements for those companies
Financial Accounting Standards Board (FASB)
– issues pronouncements that dictate the way in which financial
accounting and reporting is performed
Internal Revenue Service (IRS)
– administers and audits to ensure compliance with tax laws and
regulations
International Accounting Standards Committee (IASC)
– developing international accounting standards for worldwide
standardization
Copyright
Copyright © 2001 John Wiley & Sons, Inc. All rights
reserved. Reproduction or translation of this work beyond
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responsibility for errors, omissions, or damages, caused by
the use of these programs or from the use of the information
contained herein.
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